The financials index has been belted over 5% since bank reporting started last week. The market’s correct anticipation of the budget’s bank levy has been a key driver here, and has dominated and somewhat clouded the issue. So to get back to basics, and isolate the single most important theme to emerge from bank reporting - and its investment implications, we asked Matt Haupt from Wilson, Romano Sala Tenna from Katana, and Sam Ferraro from Evidente to give us their views.
Banks too risky until we get clarity on capital
MATT HAUPT, Wilson Asset Management
I believe the continued deterioration in Net Interest Margin was the biggest theme to come out of the half- year results. The recent repricing of loans helped alleviate the impacts of continued front and back book discounting. I believe the market was hoping for a greater impact from repricing instead it was used to help offset the discounting. Bad debts, costs, and capital were all ok.
We lightened our weightings in banks given the good run and hence valuations. I think the risk around APRA, ACCC supervision on rate settings, slower credit growth all point to subdued earnings for the banks. Until we get clarity on capital I believe there is too much risk at these levels to have large positions in the banks.
Two reasons banks could go higher
ROMANO SALA TENNA, Katana Asset Management
The May 2017 Bank reporting season was largely in line with expectations. Top line earnings were subdued due to constrained credit growth and flat or contracting net interest margins. This was offset by cost discipline, yielding modest earnings per share growth of low to mid-single digits.
Perhaps the most important theme was that capital generation was stronger than anticipated as indicated by the CET1 ratios at or around the ~10% level. This was predominantly due to a reduction in risk-weighted assets. Why is this significant? In effect it strengthens the likelihood that the major banks will be able to maintain their respective dividends at the current levels into the second half of the financial year (subject of course to regulatory changes).
The latest set of results was very much in line with expectations and hence has minimal impact on our current assessment. In short, we see that current bank valuations are at the top end of their historical range in terms of both price to book value and price to earnings, and some way above on a Price to Earnings Growth (PEG) basis. Given the position in both the housing and interest rate cycles, this would normally generate an outright sell.
However, there are 2 factors that mitigate this view:
- The first of these is the likelihood of out-of-cycle rate rises, which will provide a partial earnings buffer.
- The second is the ‘weight of money’. Exchange Traded Funds (ETFs) are growing rapidly and the big 4 banks represent 29.12% of the S&P ASX100 and a staggering 46.55% of the S&P ASX20. As many of the larger ETFs run on these types of indices, it means that close to half of every dollar spent on an Aussie ETF is likely to find its way into one of the four banks. This is an emerging dynamic that can out-weigh valuations and underlying fundamentals.
We nonetheless remain underweight the banks, but are cognisant that these factors could see them trade higher.
Banks cheap compared to other industrials
SAM FERRARO, Evidente
A lift in bank provisioning was a key theme to emerge from the sector’s reporting season. The historically low rental yields in residential but particularly commercial property have seen the banks rightly adopt a more conservative stance provisioning. The focus on asset quality in these areas is likely to continue for the foreseeable future.
There is plenty of bad news buffeting the sector and the introduction of a levy on banks’ liabilities will only see sentiment worsen in the near term, with analysts expected to downgrade their earnings forecasts. But I remain positive on the sector because pricing suggests that investors have become too gloomy on the sector’s prospects. The sector is trading on a book multiple of 1.9x which represents a 50% discount to the non-bank industrials. In the past two decades, dispersion of this size has only occurred two other times; during the financial crisis and in the early 2000s (see chart). Despite the fact that higher capital requirements have crimped the banks’ ROEs, the sector’s profitability remains higher than non-bank industrials.
The single biggest risk to the banks
See what our panelists named as THE single biggest risk to the banks: (VIEW LINK)